Qwest and US West have their roles reversed

So Qwest is going to buy US West . . . maybe. Or maybe it's buying US West and Frontier. Or maybe Global Crossing is buying US West and Frontier, or maybe it's buying only Frontier. It's enough to give you a headache, especially considering it's US West that should be doing the buying.

Qwest's fundamental business proposition involves using IP technology to build a long-haul network so economical that service costs will be far lower than those of incumbent interexchange carriers such as AT&T, MCI and Sprint. This will let Qwest discount its services sharply, win over its competitors' customers and still earn tons of money. In a recent Network World article, Qwest competitor Level 3 likewise talked about dropping voice prices radically and regularly.

But let's take a closer look at this scenario. Long-haul bits are getting really inexpensive, right? In fact, IP fans keep telling us that "bandwidth is free." Qwest, therefore, is in the business of selling something that's cheap today and will be free tomorrow - at least if you believe classical wisdom.

Forgive me, but the business model that lets you make a profit selling something that's free escapes me.

Yet strange as such a business model may be, it does explain why Qwest would want to buy US West. Nobody, after all, is proposing that access is going to be free. In fact, one might well conclude that customer access will be the key competitive asset among service providers. After all, that free bandwidth has to be delivered by someone. Wireless providers may propose their technologies as alternatives to the copper loop, but with about 170 million copper loops in the ground today, the loop owners are reaching a lot of customers at a very low cost.

This, of course, raises the question of whether the roles of seller and buyer have been somehow reversed in the Qwest-US West deal. If Qwest is looking at steadily declining bandwidth costs, reducing them at some point to essentially zero, where is it getting the money? Why isn't US West, whose customer-access assets should be getting more valuable as competition heats up, buying Qwest instead?

Some see a plausible answer in the regulatory situation. The telecom act is supposed to keep the regional Bell operating companies out of the long-distance market until they've complied with 14 proof points in opening their own local exchange markets to competition.

But close examination of the act shows that RBOCs can get into the long-distance business immediately, except in their home regions. US West could be selling long-distance services today, so why not just buy Qwest?

The answer may lie in Wall Street's unrealistic view of our industry. A company can acquire another company most easily if the buyer has a high total stock value - the "market capitalization," or market cap. A high market cap in the technology sector isn't based on earnings (which US West has), but on the assumption that a lot of stock purchasers will believe the company will have better earnings in the future. Real earnings in the present can just get in the way of a rosy set of expectations, and that can really contaminate not only company valuations, but also our whole industry.

Let's look at the statistics for a moment. Qwest isn't ranked on the Fortune 500. Its latest quarter revenue was about $880 million. US West is 135th on the Fortune list for 1999, earning $3.2 billion in the latest quarter. Cisco is 192nd on the list and earned $3.1 billion in the last quarter. So why doesn't Qwest buy Cisco instead? Because Cisco's market cap is 10 times that of Qwest ($206 billion to Qwest's $23 billion), while Qwest nearly matches US West's $29 billion capitalization.

Obviously, Cisco's future is best, Qwest's is second and poor US West's is last, based on the relationship between earnings and Wall Street's assigned value.

Or is it? Could it be that this whole high-tech valuation process is nothing but a big fraud? Is it possible that hype sets the values of companies, and this hype is thus controlling the business of telecommunications? Sales sets earnings, hype sets market cap.

What kind of industry will we have if the most successful line of ...well, hype, rather than the most successful line of business, wins out?

We'd be better off if Qwest's and US West's roles were reversed. We'd be better off in an industry that could reverse them.